Tuesday, April 19, 2016

In our MBAG 8679A: Risk & Resilience:Applications in Risk Management class we have been discussing the links between taxation, optimal corporate capital structuring and investment, including the decisions to pursue M&A as an alternative strategy to disbursing cash to shareholders.

Per authors, “taxing capital gains is an important obstacle to the efficient allocation of resources because it imposes a transaction cost on the vendor which locks in appreciated assets by raising the vendor’s reservation price in prospective transactions.” Note, this is an argument similar to the effects of limited interest deductions on mortgages and transactions taxes on property in limiting liquidity of real estate.

“For M&As, this effect has been intensively studied with regard to shareholder taxation, whereas empirical evidence on the effect of capital gains taxes paid by corporations is scarce. This paper analyzes how corporate level taxation of capital gains affects inter-corporate M&As.”

Specifically, “studying several substantial tax reforms in a panel of 30 countries for the period of 2002-2013, we identify a significant lock-in effect. Results from estimating a Poisson pseudo-maximumlikelihood (PPML) model suggest that a one percentage point decrease in the corporate capital gains tax rate would raise both the number and the total deal value of acquisitions by about 1.1% per year. We use this result to estimate an efficiency loss resulting from corporate capital gains taxation of 3.06 bn USD per year in the United States.”

I am slightly sceptical about the numerical estimate as the authors do not appear to control for M&A successes. However, since the lock-in mechanism applies to all types of re-investment projects, one can make a similar argument with respect to other forms of capex and investment. One way or the other, this presents evidence of distortionary nature of U.S. capital gains taxation regime.

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This blog represents my personal views and is not reflective of the views or opinions held by any company, contractor, client or employer I work for currently or have worked for in the past. These views are not an endorsement to take any action in the markets or of any political position, figures or parties.

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